Understanding Market Failure and Income Redistribution: An Economic Analysis

1. Headlines Part III Economics 230 J. F. O’Connor

2. Part II Recap • Concerned with the workings of a perfectly competitive market economy with private ownership. • Demonstrated that equilibrium in such an economy is socially efficient in the sense that some could not be made better off without making someone worse off, provided certain conditions are met.

3. Conditions for Social Efficiency • No individual agent, consumer or producer, has market power • Information about prices and technology is generally available - no asymmetries of information • No externalities in consumption or production

4. Social Efficiency (contd.) • All goods are private - no public goods, no commons goods, and no collective goods • Property rights are clearly specified

5. Market Failure • Violation of one or more of the above conditions can prevent the equilibrium of a market economy from being socially efficient. We refer to this as market failure • Note that a socially efficient outcome is not necessarily fair or just

6. Content of Part III • Concerned with how an economy operates when one or more of the conditions for social efficiency are not met and what action, if any, society might take to deal with the result. • Labor Markets • Income Distribution

7. Market Power - Imperfect Competition • Monopoly, Monopolistic Competition (Mon. Comp), and Oligopoly • Main problem is that price exceeds marginal cost • Monopoly can be and is often regulated • Mon. Comp. provides variety • Oligopoly - prevent collusion and encourage them to compete

8. Information • The role of information - why professionals such as lawyers, physicians, real estate brokers, middlemen • Optimal amount of information • Asymmetric information and market failure

9. Externalities • Positive and negative each causes market failure • Positive - market produces too little, • Negative - market produces too much • Pigou - tax negative and subsidize positive • Coase - market solution under some conditions

10. Non-private Goods • Public goods - nonrival and nonexcludable - market produces too little • Commons goods - rival and nonexcludable -market uses too much • Collective goods - nonrival and excludable -market leads to natural monopoly

11. Labor Markets • Competitive labor market - equilibrium wages and employment • Explaining differences in earnings: • Human capital • labor unions • winner-take-all markets • compensating wage differentials • discrimination

12. Income Redistribution • All modern industrial societies modify both the initial endowments and the outcome of the market system. They redistribute income. Why? • Moral and practical aspects of income inequality • Methods of income redistribution